An Exception Among the Refiners

Two weeks ago, I took questions from readers before a short week, and many of the questions centered on the refining space and on CVR Refining LP (CVRR), a master limited partnership that I had recommended at its IPO price of $25.

Last Monday, my column again centered on refiners and the increasing difficulty I believed they would continue to see in the coming months. I even made the case that the mid-Continental refiners, of which CVRR's parent company, CVR Energy (CVI), is one, would be in for the worst case of all the refiners, except for the refiners that rely upon crude-by-rail.

So how can I still be favorable toward CVRR, given the negative outlook I have toward the refiners and toward CVR Energy in particular?

The question goes a long way to understanding how fundamentals get translated into trading ideas and how sometimes there are values to be had even in sectors that are up against it fundamentally.

Yes, it is true that the disintegrating spread between West Texas Intermediate and Brent crude is putting tremendous pressure on the margins of refiners, particularly mid-con refiners -- this is what forced the new and horrible earnings-per-share guidance from Valero (VLO) in its recent quarterly report, and other refiners are sure to follow with negative reports and outlooks. CVRR is hardly immune to this, and as the Brent/WTI spread goes to parity and beyond, as I believe it will, margins and revenue will also decline, putting its very generous distribution is some jeopardy.

So, am I recommending that this stock be sold? On the contrary. There is nothing in the fundamental outlook for CVRR that isn't already deeply represented in the stock. In addition, the original IPO price was so deeply undervalued to the potential distribution that even slightly weaker margins cannot push the price of shares down much more, in my view.

Add that to the secondary offering about a month ago that was designed to purchase shares back from the parent company, and the overwhelming interest of super-trader Carl Icahn in the company, and you've got a stock that has been sold off significantly on the basis of a refinery trade without regard to its individual strengths.

Let's recap: The current distribution being delivered by CVRR at $6.32 a share represents over 22% in yearly dividend. Considering the current environment for the refiners and particularly the mid-Continental refiners, that distribution is almost guaranteed to take a cut, although probably not before the first quarter of 2014. The stock has run as high as $35, which was more in line with a stable distribution, but since shares are closer to the original IPO price, this remains one of the few values left in refiner MLPs.

My recommendation has also recently included a sale of call options against owned shares, a covered call strategy which would offset any cut in the quarterly distribution that's almost sure to come.

In short, you can dislike a sector fundamentally but still see value in individual issues inside that sector. And in CVRR, I still see that value strongly. Recommended.